The Motley Fool

The 3 Phases of a Bear Market

Bear markets are brutal and savage events that can leave many investors scarred and horrified. Sometimes investors get mauled so badly by the bear that they quit investing altogether and park their money in “safe” savings and deposit accounts, not caring if their money is eroded by inflation. Such investors may not be aware of how to react during a bear market.

A bear market is characterised by three distinct phases of psychology. By understanding each phase, investors can become more aware of how they should think about companies and also how to deploy their capital. With this knowledge, investors can hopefully improve their performances and have peace of mind.

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Denial phase

In the denial phase, the market takes a dip from bull-market highs. However, the majority of market participants remain optimistic and sanguine and only see bright days ahead. They often treat the dip as a temporary rest for the market to then begin its next leg up. Positive news continues to flow, and negative news is either ignored or downplayed.

During this phase, investors are often eager to continue accumulating shares on every market correction, believing that the “best is yet to come.” The widespread belief is that growth is still present and that there are no dark clouds on the horizon.

Concern phase

As the market continues to make lower highs and fails to exceed its previous all-time high, investors start to show more concern. There is now some evidence of the news getting worse, with lagging economic indicators suggesting that all is not rosy. Investors start to form doubts over the strength of the bull market, and some may start to take profits or cut losses, but the majority still continue to hang on — or even buy more in the faint hope of a recovery.

As the market continues to head lower and more bad news bubbles to the surface, more and more investors start to throw in the towel and sell their investments. There is a growing awareness that things could get worse, and people’s optimism swings to pessimism.

Capitulation phase

The final phase of the bear market is that of capitulation. During this phase, bad news takes centre stage, and there is widespread pessimism and fear. The market continues to plummet as companies report poor earnings (or even losses) and communicate bad or uncertain prospects. Valuations start hitting multiyear lows, and the cycle of fear is feeding on itself, creating sharp share-price declines that are misaligned with fundamentals.

During this final phase of the bear market, many investors sell their investments in despair — usually at the very bottom. Investments are sold off for emotional reasons rather than as a result of rational analysis. This pushes prices down to ridiculous lows and sets the stage for the next bull market to emerge as the smart money recognises a good bargain and starts to slowly accumulate shares.

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The information provided is for general information purposes only and is not intended to be personalised investment or financial advice.